Deripaska has picked up a stun gun

01.12.2011 — Analysis

The decision to shut down the electrolytic production process at Bogoslov Aluminum Plant in the Sverdlovsk region could be seen as the beginning of the end for UC RUSAL. The company is mired in debt, its revenues and operating margin are declining, and the financial statements of its biggest companies have been labeled as classified. Challenging times await the co-owner of this aluminum empire, Oleg Deripaska. In the near future, the Russian prosecutor general's office could launch an investigation into his alleged ties to the Russian mafia in Europe.

What's happening to the profits?

The company's financial statements indicate that things are not going well. Analysts from Veles Capital emphasize that UC RUSAL's net profit for the first nine months of 2011 (according to IFRS) decreased by 14.7% - which amounts to as much as $1.2 billion. The company's operating profit decreased by 8% in the third quarter - which comes to as much as $555 million, and revenue fell by 5% - up to $3,126 million.

As these problems have developed, the company has been increasingly forced to borrow money. In early November, 2011, UC RUSAL received a syndicated loan of $4.75 billion, secured by its blocking stake in factories in Bratsk, Krasnoyarsk, Sayanogorsk, and Novokuznetsk, as well as the Siberian-Urals Aluminum Company, all of which belong to the holding company. Much of this money will go toward paying off current liabilities.

Russian analysts are unable to objectively assess how indebted the company is or whether it has a financial future. According to The Moscow Post, reporting statements from JSC Krasnoyarsk Aluminum Plant, JSC Achinsk Alumina Refinery, and several other manufacturing assets are not being made public.

Soon, however, the Russian prosecutor general may begin a close examination of the financial postings from the RUSAL group. On Nov. 15, 2011, The website InoPressa.ru cited a story in the newspaper El Mundo, describing how a judge in the Spanish National Court, Fernando Andreu, asked Russian authorities to begin an investigation into the alleged ties between aluminum magnate Oleg Deripaska and the Russian mafia in Europe. According to Lenta.ru, the judge hopes that an investigation will be carried out in Russia, because "it was in that country that the illegal activities of the Izmaylovskaya criminal organization were founded, formed, and carried out. It was in Russia that the orders were given and plans were made to launder money".

The Spanish judge found that Deripaska and his partners had received revenue from several Russian companies between 2001 and 2005. The court papers mention that the businessmen had established control over these companies "by means of racketeering, fraud, and murder". The money they received was legitimized through the company Vera Metalúrgica, S.A. Fernando Andreu has asked the Russian authorities to inform him of their decision, so that if they refuse to proceed he may resume his own investigation.

Radio Liberty quoted Deripaska's representatives, who reject the accusations against their employer, "It is clear that the Spanish investigation does not and could not have any evidence of any illegal activity by Mr. Deripaska. We are confident that the relevant Russian authorities will uphold this position and end this misunderstanding".

However, according to Lenta.ru, the Russian prosecutor general's office has already expressed an interest in the investigation underway in Spain and is prepared to shoulder this challenging task.

Total cost-cutting

With the storms raging all around it, UC RUSAL has been forced to make cuts. The company has focused on lowering its electric bill. The first significant step was shutting down the electrolytic production process at Bogoslov Aluminum Plant. Oleg Deripaska is not satisfied with the price of electricity in the Sverdlovsk region, which is twice the national average in Russia.

In mid-November there was a wave of closures of electrolysis baths at Bogoslov Aluminum Plant. All 130 baths are expected to cease operations within 4-6 weeks. Some of the workers who have lost their jobs will be transferred to more modern facilities that are fitted with gas-treatment equipment, while others will be shifted to alumina production. The owners will give a few the opportunity to move to similar businesses owned by the company but located in other regions of Russia.

UC RUSAL's management has officially stated that aluminum production at the plant is hugely unprofitable. The production cost for a ton of materials is $700 above the price on the London Metal Exchange. The losses are the result of continuous increases in the rates for electricity in the Sverdlovsk region, which increased by a third in 2011 and will go up another 8% next year. Bogoslov Aluminum Plant currently pays twice as much for its electricity as do RUSAL's factories in Siberia, and 150% more than the costs incurred by the company's aluminum plant in Sweden. Insiders claim that the owners of the metallurgical company were upset with a regional government that permitted a market for electricity to develop that fleeced the biggest energy users.

The response to that charge was swift. Governor Alexander Misharin rejected the accusations of inaction and implied that it was time for a change in the management at UC RUSAL overseeing the development of the Urals aluminum plant. He thinks that the high production costs are the result of poor quality control at Bogoslov Aluminum Plant. Aleksandr Petrov, the deputy chairman of the government of the Sverdlovsk region, continued with this theme when he suggested that UC RUSAL build their own generating capacity in the region and undertake a complete reconstruction of the plant, investing in an increase in the value-added of its aluminum products.

The metallurgists fought back. Oleg Deripaska's team believed that the advice to modernize RUSAL's facilities merely showed the unwillingness of Aleksandr Misharin's government to resolve the Sverdlovksk region's increasing number of problems related to electricity supplies. "There is no question that we support the development of a cluster of aluminum producers in the Urals. But we would also like to point out that the production of primary aluminum and its alloys is a completely different type of business than the production of high-value-added products. RUSAL's businesses are not involved in downstream production. That is not a core business for our company", claimed RUSAL's representatives.

RUSAL's Chinese campaign

The cost of electricity per ton of aluminum produced in Russia is among the lowest in the world, only $390 compared to $700 in Eastern Europe and $590 in Latin America. China has the most expensive electricity (accounting for $1,000 of the production cost of a ton of metal), but paradoxically it is in the Middle Kingdom that UC RUSAL has acquired two cathode plants.

China is developing rapidly and it lacks the manufacturing resources to meet its own need for aluminum, which is why the "winged" metal there costs more than on the London Exchange. And sizable profits make it possible for the company to ignore the cost of electricity. For this reason, the owner of the largest stake in UC RUSAL, Oleg Deripaska, is making a pragmatic decision - to close his unprofitable plant in the Urals and move that money to China. He plans to significantly expand his presence in that country, buying a 33% stake in a subsidiary of the Chinese state-owned corporation Norinco, which sells primary aluminum on the Chinese and Southeast Asian markets.

Who will pay for the renovations?

But the owners of the metallurgical company look vulnerable in their dispute with the authorities of the Sverdlovsk region. According to Aleksandr Tatarkin, the director of the Institute of Economics of the Urals branch of the Russian Academy of Sciences, the issue of renovating Bogoslov Aluminum Plant dates back to the Soviet era. A few decades ago, it became clear that it was necessary to build a new factory, because the outdated plant consumes too many resources. The reserve of raw materials for the Urals aluminum plant also needs an overhaul. Production from the bauxite mine in the North Urals owned by UC RUSAL is unsatisfactory in quality, price, and volume. The company is paying for the cost of transporting bauxite (the raw material from which alumina is produced), bringing it to the Sverdlovsk region from other areas. And Bogoslov Aluminum Plant is currently the third largest producer of alumina in Russia, so the plant must be writing checks with lots of zeros.

Experts agree that there is a certain logic to UC RUSAL's actions, but they cannot understand why the company does not want to recycle aluminum in the Urals. According to the metallurgists' own data, recycling requires only 5% of the energy used to produce aluminum from alumina. Although UC RUSAL's profits are diminishing, they should still be able to renovate their factories and produce higher-value-added products. But no mention is being made of investing or modernizing their facilities.

It is possible that the federal budget may end up paying to renovate Bogoslov Aluminum Plant. Russian Prime Minister Vladimir Putin previously announced the extension of a program that supports cities closely tied to a single manufacturer, and Bogoslov Aluminum Plant is the economic backbone of the town of Krasnoturinsk. If there is a dramatic drop in production at the plant, it might well be given assistance from the federal coffers.

Political blackmail

This industrial conflict in the northern Sverdlovsk region occurred on the eve of the elections for deputies to the Russian Duma, and not long before the presidential race. The federal authorities entrusted Gov. Aleksandr Misharin with the task of providing the ruling party with the votes it needed. But meanwhile, UC RUSAL's actions are inciting the anger of the region's residents. There was a demonstration in Krasnoturinsk last week, and pickets were organized in the city.

As acknowledged by Vladimir Mashkov, the chairman of the Sverdlovsk regional Duma's committee on industrial policy, the possibility of partially shutting down production at Bogoslov Aluminum Plant is under discussion elsewhere in the region. "I think the managers of Bogoslov Aluminum Plant needed to come to the negotiating table on a regular basis to resolve all their issues without stirring up conflict", he claims.

Local politicians are convinced that it was no accident that the "demise" of the electrolytic production process at Bogoslov Aluminum Plant was announced right before the elections. Andrei Alshevskikh, the head of the Communist Party fraction in the Sverdlovsk regional Duma, claims, "Gov. Misharin will get down on his knees before the owners of UC RUSAL, in order to put off a decision on the issue until the spring of 2012, after the elections".

UC RUSAL is already seeing the first payoff from the pressure it exerted. Anatoly Sukhov, the vice speaker of the Sverdlovsk regional Duma, claimed that the authorities have begun negotiating to bring down the price of electricity for Bogoslov Aluminum Plant. According to him, the regional government has prepared several drafts of a resolution to this effect.

But Aleksandr Misharin did not pass up the chance to ask Dmitry Medvedev for help curbing Oleg Deripaska when the Russian president was visiting Ekaterinburg the other day. The head of state nodded approvingly and forwarded his request to the government. It is the ministers in Putin's cabinet, after all, that are the experts in managing Russian oligarchs.

Konstantin Dzhultaev and Vladimir Terletsky